Just as the International Monetary Fund seeks to follow through with its stated intention to toughen up its global exchange rate surveillance (Profit & Loss, June 2007), the fund’s first initiative has met with opposition from China, which is concerned that the IMF framework will provide support for those in the US that claim China is a “currency manipulator”.
While the US administration recently pulled back from naming China as such, pressure continues from within the US Congress where a bi-party bill has been introduced by Senators Chris Dodd and Richard Shelby.
The IMF’s executive board last week provided members of the Fund with a new legal framework for bilateral surveillance and the way in which it is able to monitor and assess countries' economies. On presenting the report, IMF managing director Rodrigo de Rato says in a statement, "The change we are making is the first major revision in the surveillance framework in some 30 years, and it is the first ever comprehensive policy statement on surveillance. The new decision reflects current best practice in our work of monitoring members' exchange rate policies and domestic economic policies. It reaffirms that surveillance should be focused on our core mandate, namely promoting countries' external stability. And it gives clear guidance to our members on how they should run their exchange rate policies, on what is acceptable to the international community, and what is not.
"To three existing principles relating to exchange rate manipulation pursued for certain purposes, and to when and how it is desirable to intervene in the foreign exchange rate markets, the decision adds a fourth principle: a member should avoid exchange rate policies that result in external instability. The decision also adds seven appraisal indicators.”
The seven indicators as provided by the IMF are:
(i) protracted large-scale intervention in one direction in the exchange market;(ii) official or quasi-official borrowing that either is unsustainable or brings unduly high liquidity risks, or excessive and prolonged official or quasi-official accumulation of foreign assets, for balance of payments purposes;(iii) the introduction, substantial intensification, or prolonged maintenance, for balance of payments purposes, of restrictions on, or incentives for, current transactions or payments, or the introduction or substantial modification for balance of payments purposes of restrictions on, or incentives for, the inflow or outflow of capital;(iv) the pursuit, for balance of payments purposes, of monetary and other financial policies that provide abnormal encouragement or discouragement to capital flows;(v) fundamental exchange rate misalignment;(vi) large and prolonged current account deficits or surpluses; and(vii) large external sector vulnerabilities, including liquidity risks, arising from private capital flows.
"Until now, our surveillance policies have been based on a framework agreed in 1977,” explains De Rato. “Our members felt the time was right for bringing this key activity up to date. This updating was needed because the 1977 Decision does not address the developments that have most challenged the stability of the system in the past thirty years. Reflecting the period when it was drawn up, it focused on potential exchange rate manipulation undertaken for balance of payment reasons and on short term exchange rate volatility. By contrast, the most prevalent exchange rate related problems since then have been the maintenance, for domestic reasons, of overvalued or undervalued exchange rate pegs and, more recently, capital account vulnerabilities.
"The decision taken has very broad support, including from industrial countries, from emerging economies and from developing countries. The breadth of this support is telling, because it demonstrates very broad ownership of the way that Fund surveillance will be strengthened and of members' responsibilities in the process. This decision is good news for IMF reform program and good news for the cause of multilateralism. The new decision will sustain even-handed treatment of Fund members, which is at the core of a cooperative institution. This progress will also help us move forward with the other elements of our reform program, to help all of our members meet the challenges of 21st century globalisation."
Although US Congress has been much harsher in its criticism of China’s exchange rate policies, US Treasury Secretary Henry Paulson has taken a softer public approach. Addressing the House Committee on Financial Services last week, he told Congress, “Treasury did not determine that China's exchange rate policy was carried out for the purpose of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade. But, Treasury continues to press the Chinese to increase the flexibility of their exchange rate.
“Although they have taken some steps towards greater flexibility in the short term, they need to accelerate that movement and move more quickly to a market-determined exchange rate in the medium term,” Paulson added. “While currency reform is not going to eliminate our trade deficit, a market-determined exchange rate that reflects the underlying fundamentals of the Chinese economy is an important ingredient to sustainable, balanced economic growth in China, which is critical to continued stable growth around the world. The huge inflow of liquidity under the current exchange rate policy undermines the effectiveness of China's monetary policy and fuels excessive growth in credit, which itself poses significant risks for the Chinese economy's performance. The risk that China now faces is moving too slowly on exchange rate reform, rather than moving too quickly.”
Paulsen found scant support from the Senate, where the Dodd-Shelby Bill changes the definition of currency manipulation, thus making it harder for the US administration to avoid making the charge. “Just last week, the Treasury Department admitted that there exists ‘heavy foreign exchange market intervention by China's central bank to manage the currency.’ Yet Treasury still refuses to officially identify China as a currency manipulator, despite this evidence that the Chinese government is continuing to undervalue its exchange rate against the US dollar,” Dodd says in a statement. “By failing to call it as they see it, the Treasury Department is neglecting its responsibility to American workers and businesses. This legislation will put American policy where it belongs – on the side of American workers and businesses.”
Senator Shelby adds, “The facts clearly show, and I have long believed, that China manipulates its currency thereby giving it an unfair trade advantage. The fact that the Treasury Department relies upon an intent finding demonstrates the clear need for legislation. The Strategic Economic Dialogue with the Chinese is important and must continue. However, it is time for the US to avail itself of every tool available to it under the international trade and finance system – a system that the Chinese have signed on to and agreed to follow the rules of as price for entry. I believe that this legislation will provide the Treasury Department with the impetus necessary to produce real results, and I look forward to working with Chairman Dodd to expedite it through the committee process.”
With China clearly an undertone to the IMF report, a speedy response was forthcoming in the form of an article in the official newspaper, China Daily, which reported that China has expressed "reservations" about the ruling. "As it does not fully reflect the opinions of developing countries, China has expressed reservations about the adoption of this decision," says a statement from the People's Bank of China. "Past experience has shown that exchange rate adjustment has a role in resolving external imbalances, but it is not the fundamental and only instrument to that end. In the past years, many developing countries, China included, have worked hard to adjust their domestic economic structure, improve market mechanisms and increase exchange rate flexibility. These efforts have contributed to the rapid growth of the global economy."